David Callaway

Commentary: Full probe of specialists needed

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SAN FRANCISCO (CBS.MW) - The New York Stock Exchange's plan to split its chairman and chief executive roles and cut the size of its board by two-thirds should be applauded, as a first step.

But any change at the top without a thorough probe of the specialist trading system at the heart of investor concerns about fair pricing on the world's largest stock market is merely a Wall Street version of musical chairs.

Under the plan, forged by interim Chairman John Reed and approved by the Securities and Exchange Commission Wednesday, the NYSE will throw out the 27-member board handpicked by pay package glutton Dick Grasso, and instead institute an eight-member board handpicked by Reed.

Some of Reed's candidates, like Marshall Carter and Dennis Weatherstone, formerly heads of State Street Boston and J.P. Morgan respectively, have solid, above-reproach career backgrounds. But they are still Wall Street insiders, just like the ones Grasso had chosen and who signed off on his $188 million pay package.

And while John Thain from Goldman Sachs
GS,
+1.44%,
appointed the new CEO on Thursday morning, also enjoys a sterling reputation on Wall Street and is respected for his knowledge of trading systems, he also comes from a company that is an exchange insider. Goldman owns one of the seven specialist trading firms on the NYSE, Spear, Leeds & Kellogg.

Reed's plan to separate the chairman and CEO job goes a small step toward restoring confidence in the NYSE's management by theoretically preventing any power grab by one individual. But as the primary request made by SEC Chairman and former NYSE head William Donaldson, it was a sure thing in any proposal.

The real thing missing here is any sort of stronger rhetoric out of Reed or Donaldson about the examination of the specialist trading system itself, where floor members are allowed to step in and out of trades under the argument that they can create a more efficient market.

While the argument sounds logical, the potential for abuse is enormous. Boiled down, the current system gives specialists the ability to step in front of trades to trade for themselves and take advantage of their knowledge of where trading patterns are going to make a quick profit.

Of course, the specialists say examples of this abuse are few and far between. But after three years of corporate scandal, in which astonishing corruption and greed has been exposed at almost every level of the financial industry, it's a huge leap of faith for most investors to believe the genial gents rustling around behind Maria Bartiromo on the NYSE floor are the only clean ones of the lot.

That's the point that California Treasurer Phil Angelides tried to make earlier this week when he spoke for the California Public Employee's Retirement System, which sued the NYSE and its seven specialist trading firms, alleging chronic abuse of the trading system at the expense of small and large investors alike. It was the first suit accusing the NYSE of failing to police its members adequately.

While the political symbolism of filing suit the day before the SEC was to approve Reed's plan was obvious, the underlying message is still important. The SEC and the NYSE need to spell out for investors, just how clean or dirty this system is, with numbers and actual examples. Names need to be named.

The SEC got the ball rolling with a confidential report in October, leaked to the press and cited in the Calpers suit, which indicated the system was rife with corruption. The SEC's enforcement division is still investigating the particulars, and another examination of the NYSE floor operations is set for early next year.

If there is no whitewash, and under Reed's new board we shall hope there won't be, my bet is that these probes will show that far from an efficient market, the old-fashioned specialist trading system will be exposed as one of the biggest profit skimming efforts in Wall Street history. And even more audacious, all of it right in front of our eyes on the television cameras each day.

The only way to restore confidence, before or after this comes out, is for the NYSE to finally separate its market functions from its self-regulatory operations.

Only then will the legacy of Dick Grasso at last be expunged from the floor of the exchange, and the confidence of investors, from the little guy with $5,000 in a retirement account to the $155 billion Calpers pension system, finally return.

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